Global equity income funds have been seeing a surge in popularity. They were the second best-selling IA sector in the last set of retail sales statistics, while data providers are reporting increased search volume for funds in the sector. Having spent some years as the poor relation of the global sector due to their underweight positions in technology, is it their turn in the sun?
The global equity income sector has pulled off the rare feat of strong performance over both one and three years, managing both sides of the growth/value rotation and back again. Over three years, the average fund is up 44.4%, making the sector the sixth best-performing overall. It proved defensive in 2022, with the average fund dropping just 1.2% (compared to 11.1% for the global sector), and has remained robust for the year to date in spite of the recent rally for technology.
This represents a renaissance for a sector that had dipped off investors’ radars during the technology rally. Global equity income funds generally couldn’t hold low-dividend paying technology stocks, which hurt relative performance. The reversal in fortunes for some of these lower dividend, higher growth stocks has given the sector a welcome boost in the wake of rising interest rates.
It has also been a better period for some of the typical equity income stocks that feature in these portfolios. In the recent results season, groups such as Unilever, Nestle and Proctor & Gamble, have shown the power of their brands and delivered earnings ahead of expectations. Many have been able to pass on rising prices over and above the rise in their input costs, pushing profit margins higher.
James Harries, manager of the Trojan Global Income fund, says: “We have seen the return of the incumbent. As cheaply-funded, fast-growing but non-profitable businesses drop away, the more established, worthy but dull businesses that have spent years entrenching their competitive position are coming back to the fore. It’s been interesting to see areas such as consumer staples re-assert their prowess, showing their resilience and their ability to deal with challenging environments.”
Ben Lofthouse, manager of the Henderson International Income trust, says that the conditions are in place for future growth in the sector: “Our data for the Henderson Global Dividend Index shows compounded growth of dividends has surpassed 5% for the past decade. Places like the US, which people don’t think of as particularly strong on dividends, are regularly growing at 10%. There’s no reason that should change. The trends for dividends remain very similar looking out into the next 10 years and, in some sectors, they are going to be better. In utilities, for example, electrification spend is likely to see them grow their asset bases more.
“Equally, areas such as banking were completely washed out, so they’re starting to grow their dividends again. Because of that rebasing effect from the over-payers, investors are starting on a much cleaner base.”
The growth effect?
The technology sector is currently seeing a tentative revival after a dismal year in 2022. Recent results for the global technology giants have exceeded expectations and ensured that any predictions of the death of the FANGs now looks premature. If there was a revival in this part of the market – perhaps in response to a pivot on interest rates from the Federal Reserve – the global equity income sector may see relative performance start to dip again.
However, Nicolas Simar, co-head of equity income in Emea, Goldman Sachs Asset Management, says the breadth of global equity income strategies allows them to target industries seeing structural growth even if some of the higher profile technology names are off-limits. That includes industrials with exposure to process automation, energy savings and electrification of the economy or even the semiconductor sector, with its exposure to the energy transition and electric vehicles.
Equally, he agrees with Lofthouse that some traditional equity income sectors may offer more growth in future: “Gaining exposure to the reopening of the economy and the recovery of the service sector can be done via the transportation sector with companies exposed to airport and/or motorways concessions businesses.”
Luc Plouvier, senior portfolio manager on the high dividend strategy at Van Lanschot Kempen, agrees, highlighting Telcos: “The sector has been ‘disrupted’ by new competitors using low cost funding to invest aggressively and gain market share. However, at the same time, a wave of capital expenditure to roll out next generation of fixed and mobile networks pressured free cash flow. The sector has derated and currently trades at an attractive valuation, but we see these issues fading.
“Competition is becoming more rational as the industry ‘disruptors’ are seeing their cost of capital increase strongly. While at the same time, the peak in capital expenditure for network investments appears to have past.”
There are tougher areas, such as energy. Harries points out that despite OPEC’s announcement of cuts to oil production, the oil price has continued to decline. The oil majors, traditionally a bulwark for equity income portfolios, have a hill to climb in terms of the capital spending required to re-engineer their businesses for the energy transition. Opinion is very much divided on whether these fossil fuel behemoths can continue to make progress from here.
The ability of global equity income funds to deliver a growing income is likely to be important in future now bonds offer a higher yield.
Simar concludes: “The landscape for global income remains constructive despite the slowing economic environment we face. Dividends typically offer a more stable trend over time compared to earnings and, while the market expects flat earnings growth this year in the US and European markets, dividends should be able to grow low-single digit over 2023.”
In an environment of higher structural inflation, this may mean global equity income funds have a ready market for the near term.